Tags: Barry Ritholtz
Last year I got an email from a Matrix reader, Ben Tanen, a former VC now running his own investment partnership that invests in public companies, with an interesting take on the buying power of gold as it relates to Manhattan apartments.
Like many things in my life, I let this “nugget” (sorry) slip through the cracks last year. He recently updated it with our new numbers in the recent release and it’s quite compelling.
The value of gold has risen sharply in recent years during the wobbling of the global financial markets – investors see precious metals like gold as a way of preserving purchasing power over the long run. In fact, in 2011, gold had more purchasing power relative to Manhattan real estate than at anytime during the past 22 years (the limit of our publicly released data).
It would take 908 ounces of gold to purchase the average Manhattan apartment versus the 1996 low point of 1,030 ounces, a point where many think our asset bubble problems began (stocks, then housing).
Robert Moses, the Master Builder of New York, famously uttered these words at the groundbreaking of Lincoln Center in NYC.
You cannot make an omelet without breaking eggs.
I highly recommend The Power Broker by Robert Caro (and his LBJ trilogy) that chronicles Moses’ life but make sure you dedicate a lot of time – it’s a long read.
Amid the scrambled (sorry) state of financial reform going on in Washington right now is the underlying newly realized immovable object and the likely outcome for Wall Street:
Ok, eggs not a great analogy but I needed to squeeze one of my favorite quotes of all time in somehow. Lower leverage is in the future of Wall Street. Take lower risks and there are lower returns to firms eventually translating into lower compensation, translating into tempered housing demand.
This Monday federal regulators finalized guidance on a hot topic as of late: executive compensation:
The final guidance is similar to what the central bank proposed in October, but would now apply to the entire banking industry. Previously, its efforts targeted only holding companies and state-member banks…
The final guidance did not change the three initial goals of the Fed’s proposal: providing incentives that appropriately balance risk and financial results and discourage risk taking; matching “effective controls and risk management”; and supporting corporate governance.
Risk, risk, risk
Senior Economist David Belkin of NYC’s Independent Budget Office received a flurry of media coverage for his post titled “Wall Street Wages: A Rough Ride on Easy Street:”
Much has been made in recent months of last year’s record profits on Wall Street, the myriad ways (near-zero interest rates, bailouts, accounting rules changes) that government policy boosted those profits, and the seven or eight figure bonus packages that some Wall Street executives awarded themselves from those profits. There has been less said, however, about what happened to aggregate wages and salaries across the securities industry in New York City in 2009. Not only did wages fall, but the fall was the steepest in modern history—including the Great Depression.
Adjusted for inflation, average wages in the securities industry plummeted 21.5 percent in 2009 and 24.6 percent over two years.
A key economic engine in the New York City metro area that provides 25% of personal income and 5% of the employment and creates 2.5 private sector jobs for each securities job, this should also be a concern for sustainability of the current level of housing demand.
Ironically Wall Street has been telling us this for years: past performance does not guaranty future returns.
Tags: Wall Street Bonus
I was listening to the C-SPAN Q&A podcast which was an interview with producers Leslie and Andrew Cockburn on their new independent film called American Casino which chronicles the breakdown of subprime lending via Wall Street. The starting point is subprime mortgage lending in poor neighborhoods of Baltimore.
The foil is Phill Gramm, Chairman of the Senator Finance Committee who in a masterstroke of politcal management, on December 15, 2000 at 7pm, appended a 260 page financial de-regulation bill to an 11,000 page appropriations bill just before the holidays, and because it was in the 11th hour, it was likely few read it and Clinton signed it. The bill exempted the financial instruments used in the credit boom from federal and state regulations – free of any supervision.
Gramm is now Vice Chairman of UBS.
This topic is nothing we haven’t heard before but its focus on Gramm is an interesting angle. I listened to the entire C-SPAN interview and while I enjoyed it, the story feels a bit tardy (although certainly very important because the pain is still playing out).
This systemic breakdown will continue to facsinate many for generations to come – hopefully serve as case study fodder at MBA programs as well.
The film credit pronouces:
“AMERICAN CASINO IS A POWERFUL AND SHOCKING LOOK AT THE SUBPRIME LENDING SCANDAL. IF YOU WANT TO UNDERSTAND HOW THE US FINANCIAL SYSTEM FAILED AND HOW MORTGAGE COMPANIES RIPPED OFF THE POOR, SEE THIS FILM.”
-Joseph Stiglitz, Nobel prize-winning economist
A few days after I heard the podcast, a federal judge threw out the lawsuit by the city of Baltimore against Well Fargo:
ruling that the city could not prove that the bank’s lending practices had resulted in broad damage to poor neighborhoods.
Perhaps a case of bad timing for the film makers? But but still a compelling story.
This weekend I ripped through a terrific book The Secret Life of Lobsters by Trevor Corson written back in 2004. Even if you’re not a lobster fan, I marveled at how he could take a mundane subject and weave an interesting (true) story on how the lobstermen of Maine have kept the production elevated for the past several decades, despite consistent claims of overfishing. (Incidentally my lobster pots were stolen this weekend, lines probably cut by commercial fisherman, plus we had 30 family members over to our house for the 4th for a lobster/clam bake.)
No one really knew whether cyclical declines in the number of pounds caught were natural or induced by man.
In other words, this is all about subprime lending.
While trying to find my interview on NPR about last week’s market reports (I was unsuccessful) I stumbled upon a WNYC interview with the Trevor Corson last week (the day our report was released) without using keywords such as “lobster,” “fishing” or “Maine”.
He correlated the sharp drop in Lobster prices this year with the collapse of the Iceland banking system via subprime lending. It’s worth a listen.
And here’s his related piece in The Atlantic magazine. Fascinating.
Basically, lobster prices have maintained a high price level for the past decade. A large portion of the catch was diverted to processing plants in Canada keeping supply of fresh lobsters restrained in the U.S. The Canadian plants shipped lobster products all over the world and were mainly financed by Icelandic banks who provided them revolving lines of credit. When the subprime crisis hit, these banks collapsed because of their heavy investment in financially engineered subprime mortgage products. As the lines of credit dried up, so did the processing plants and the excess harvests were stuck in the U.S. driving down wholesale lobster prices.
Oversupply of housing driving down prices correlates to the “V-notch” technique to increase the lobster population. I won’t even bring up the V-shaped recovery“, since I’m still full from our lobster bake.
Somehow it all comes back to lobsters.
UPDATE On a side note, the wholesale cost to restaurants has fallen sharply but the consumer is largely unaware of the drop, so restaurants have enjoyed a larger spread between what they charge you and what it costs them. Have you ever noticed how many lobster related items appear on a typical mid to upscale restaurant menu? It seems to be 4-5 items now have lobster in them. Menus used to contain one lobster item, a whole steamed version. Now lobster mac & cheese is a popular favorite. Thank synthetic CDOs for that.
The phrase “damp squib” has since come into general use to mean anything that fails to meet expectations. The word “squib” has come to take on a similar meaning even when used alone, as a synonym for dud.
Because this will take a year to enact through legislation, I wonder whether it will be relevant when the final version in place? Banks will probably be stronger. Wall Street will be in somewhat better shape. Still, I am hopeful this will be a productive effort, given the lack of effective regulation that enabled a whacked out credit environment.
On Monday, Timothy Geithner, secretary of the Treasury and Lawrence Summers, director of the National Economic Council wrote an Op-Ed piece for WaPo called A New Financial Foundation. Here’s the conclusion:
By restoring the public’s trust in our financial system, the administration’s reforms will allow the financial system to play its most important function: transforming the earnings and savings of workers into the loans that help families buy homes and cars, help parents send kids to college, and help entrepreneurs build their businesses. Now is the time to act.
The administration has been working hard to develop a plan.
Tonight, the administration released the details of the plan to revamp the financial regulatory system, one of many aspects of the financial system that didn’t function.
The Obama administration last night detailed a series of proposals that would involve the government much more deeply in the private markets, from helping to steer consumers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to prevent the kinds of risk-taking that sparked the economic crisis.
The plan is an attempt to overhaul an outdated system of financial regulations, according to senior administration officials.
It would vastly increase the powers of the Federal Reserve in an effort to create stronger and more consistent oversight of the largest companies and most important markets.
It also would create a new agency to protect consumers of mortgages, credit cards and other financial products.
I’m hoping something constructive comes out of this and not simply more regulation. This is being done in the name of prevention, and has limited impact on the current situation in the housing/mortgage/credit markets.
I can’t over the feeling that we will end up creating regulations for what we went through rather than where we are going.
Tags: Tim Geithner
Last week the New York State Comptroller announced that Wall Street bonuses fell 44% to $18.4B and the securities industry losses may exceed $35B
Troubled Asset Relief Program (TARP), which infused billions of dollars into the financial system, helped prevent more institutions from failing. TARP placed restrictions on bonuses for top executives and many have voluntarily forgone bonuses, but it did not impose limitations for lower-level employees.
State Comptroller Thomas P. DiNapoli seems to be inferring that high level executives held back and the more pedestrian lower paid employees took the money? I don’t think so. Sure, CEOs at Citi and others witheld bonus compensation, but that wasn’t in the majority. In fact 79% of all Wall Street employees got paid a bonus this year.
In fact, although the bonus pool was down 44%, it was the sixth highest payout in history.
Here’s what I wrote about bonuses last year at this time. Much has changed, other than the concepts applied to compensation (hint: they’re not correlated with performance.)
That certainly important for the New York real estate economy, but given the credit crunch, it may not prove to be much help. Each January, the bonus compensation starts the real estate market engine.
Maureen Dowd in her Op-ed piece Disgorge, Wall Street Fat Cats suggests:
The president needs to think like Andrew Cuomo. “ ‘Performance bonus’ for many of the C.E.O.’s is an oxymoron,” he said. “I would tell them, a) you don’t deserve a bonus, b) where are you going to go? and c) if you want to go, go.”
Firstly, I think we all need a refresher course on what a bonus is:
noun, plural -nusâ‹…es
1. something given or paid over and above what is due.
2. a sum of money granted or given to an employee, a returned soldier, etc., in addition to regular pay, usually in appreciation for work done, length of service, accumulated favors, etc.
3. something free, as an extra dividend, given by a corporation to a purchaser of its securities.
4. a premium paid for a loan, contract, etc.
5. something extra or additional given freely: Every purchaser of a pound of coffee received a box of cookies as a bonus.
I always saw bonus as a mislabeled compensation method – most see it as base pay plus commission. After all, the average compensation on Wall Street has averaged 40% to 50% of total compensation and bonus payouts have been at or near record levels over the past 6 years – based on nothing really. It morphed into a way to offload compensation risk to the employees. We’ll pay you half of your salary at the end of the year if we can, which morphed into no matter what.
Felix Salmon at Portfolio opines further on this point – that there is a minimum bonus payment level that must be made (seemingly contrary to Andrew Cuomo’s statement above).
Now there are good reasons for having a bonus system: it incentivizes profitable work, and it makes it easy for banks to pay less money in lean years. But as Bookstaber writes, there’s definitely an implicit minimum bonus at investment banks — a sticky level below which it’s hard to cut bonuses any further.
There are reasons to have a minimum bonus, rather than baking that money into base pay: it’s not included in pay-rise calculations, for starters. But when banks start getting multi-billion-dollar government bailouts, it looks really bad if they then just turn around and spend a similar amount of money on bonuses.
But resentment is growing and the campaign weary “Main Street vs. Wall Street” has found new life. Wall Street has lost billions, been bailed out for billions and been paid billions in bonuses. The mortgage securitization juggernaut will end up costing taxpayers trillions and the industry is whining about compensation.
Washington is angry, and perhaps embarrassed for not building this into the TARP.
But seriously, did Congress really expect Wall Street to stop paying out bonuses voluntarily? Its part of the culture, always has been. It’s like asking Congress voluntarily not to run attack ads and not be overly partisan – it’s simply built into their DNA.
No moral judgement being made here – people outside this world don’t seem to understand what makes Wall Street tick. If its not mandated, then status quo will prevail.
Even worse, the lower compensation is having an adverse effect on the social lives of Wall Street bankers, ’cause its the economy, Girlfriend.
UPDATE: Signs Wall Street may already be re-inventing itself.
Here’s a strange press release by Fitch, one of the big three rating agencies along with Moody’s and S&P.
Fitch Ratings has formalized the expanded housing-related metrics used in its public sector rating process and will continue to refine these data as market conditions warrant.
Ok, so we are getting insight from one of the big three , although Fitch is believed to be the most conservative of the three. The ratings agencies sharply downgraded billions of highly rated mortgage-backed bonds just after the credit crunch began in July 2007. I seem to recall that their models didn’t have the right data.
Fitch believes the housing downturn will be more prolonged and acute in regions that experienced the most dramatic home price appreciation and new residential development since 2000 and in regions with high exposure to sub-prime and option ARMs mortgages.
What about credibility?
The new rules by SEC to address conflict of interest could be a start.
The three firms that dominate the $5 billion-a-year industry — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — have been widely criticized for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis.
The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms.
The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company’s ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments.
These agencies need to do a lot of credibility-building going forward. I can’t help but wonder why these agencies aren’t receiving more scrutiny. How will investor confidence be restored when the ratings they relied on were inadequate?
I like to check in with bloggingheads.tv periodically – the topics can get pretty abstract for my limited intellectual capacity, but every so often it strikes a chord and today was one of those days – I saw two clips that appealed to me (They caught my attention initially because I know and admire 3 of the 4 the participants). The two sessions were covering the “subprime” situation but seemed at odds about interpreting the risk of existing financial instruments. Great comments on these posts as well.
A commenter from Yves and Dan’s excellent but far too short “Slums of Greenwich, CT” writes:
An intereresting thing here was that the interlocutors implied that the shadow banking system, and here one suspects that they mean the derivatives market, poses greater risk to the financial system than do the poorly underwritten residential mortgages. This is the reverse of what the majority of people think. It makes sense to think that the greater risk is posed by the securities which underly derivatives, that the risk posed by derivatives is entirely derivative.
In the next segment, The Subprime Solution, Professor Shiller, who has been making the rounds with his recent book suggests we don’t “blame” anyone for the crisis and discusses his ideas for a solution – the devil seems to be in the details. In the background hovers his life’s work, the advocacy of a housing derivatives market to enable investors to manage risk.
Here’s a representative comment on the post:
I understand his work-out proposal, and insofar as it would remove some uncertainty and provide a mechanism to adjust nominal terms or contract-time expectations to unexpected situations I can see the appeal, but wouldn’t all of this be incorporated into the expectations of the lender, secondary purchasers, and buyer at the time of the contract? It seems like the plan would have to make mortgages more expensive (relative to today’s–or really yesterday’s market price) to the borrower and less attractive to the secondary market. If the new contract terms were fully incorporated into the mortgage price up front, how will this solve the problem; it seems like it would shrink the market for mortgage lending without affecting the asset bubble dynamics overall. Homeownership is extremely politically popular–how would Prof. Shiller counteract this fact, in his (correct) push to remove the many subsidies for home purchases?
A fun way to deliver commentary, bloggingheads is available as a download, but it’d be a lot easier if it was a videocast via itunes.
A little levity from the Colbert Report with guest host Maria Bartiromo. My kids were watching this with me last night and loved it.
Memorable quote from Colbert:
Should I invest in paper bags for panicky people to breath in to until this thing blows over?
My attempt at Colbert paraphrasing – A free market should allow business to do whatever they want, including making a lot of bad decisions and then wait for the government to bail them out. But it is very important for business to make really big mistakes because the government only bails out the ones who screw up the most.
Sounds funny, but good grief, insanity still rules the night.
Ok, now we are getting somewhere, albeit slow as molasses.
From my perspective, these are the types of things that have to happen for the US to see our way out of this credit crunch.
Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet.
The key here is recourse. In other words, if the bank goes under the bond holder has “recourse.” A basic concept but became obsolete during the securitization hay day because as it turned out, the bond holders had little recourse since the asset was split into so many pieces, it was very difficult to track down the asset.
Covered bonds are big in Europe.
Paulson issued best practices guidance (is that corporate speak or what?) to try to get the market jump started and was joined by FDIC, OTS and OCC as well as Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo (WaMu and B of A have experience in these instruments). I wonder if WaMu didn’t attend because they are simply trying to survive?
Bankers involved in the field reckon that a US covered bond market could ultimately outstrip the roughly â‚¬2,000bn European market. However, it faces limitations in the near term due to restrictions placed on the bonds’ treatment by the FDIC, which importantly has oversight of banks if they become insolvent.
For example, the FDIC said banks should be restricted from using covered bonds for more than 4 per cent of their funding in order to avoid depleting the assets available to repay ordinary depositors and other unsecured creditors if a bank failed.
In the US, the cost of issuing covered bonds and the FDIC restrictions mean they could lie low in the pecking order of banks’ funding preferences, at least initially, according to analysts at Citigroup. Funding through Fannie and Freddie or through the Federal Home Loan Banks both appear more attractive for now, the analysts said.
FDIC created an expedited procedure for recourse for bond holders in the spring. Covered bonds are capped at 4% of total liabilities so its not a major fix, but it’s a start.
Here’s a better explanation, in the way that only Felix Salmon can provide.
The investors have to be brought back into the fold.
“Covered” seems to be a synonym for collateralized, but it also has other meanings that may be appropriate in this effort to salvage the housing market. Think of covered wagons, which can be circled in times of crisis. With banks reluctant to lend their own money for mortgages, and the private securitization market quiescent if not dead, the cost of mortgage loans has been rising even as housing prices fall, making a bad situation worse. At best, a covered bond market would provide a cheaper source of financing for banks while reassuring investors that their money is safe.
Essentially investors would buy into a pool of mortgages that would be kept on the balance sheet of the bank that made the loans. These would be high-quality loans, and at the first sign of trouble in the underlying mortgages, those mortgages would be replaced in the mortgage pool. Thus, investors would be assured of repayment unless the underlying mortgages suffered major losses and the issuing bank failed. That might make investors burned by existing mortgage securities more willing to return to the market.
At best, a covered bond market would provide a cheaper source of financing for banks while reassuring investors that their money will be safe. It is highly unusual for the government to take such a major role in getting a market established, but Treasury officials said their action was needed to get more money into housing loans.
Paulson may not be a good public speaker, but he brought something tangible to the table.
And credit for his move is covered. (ok, sorry)